Positives outweigh the negatives, top forecaster says

O'Sullivan of MF Global wins his eighth award from MarketWatch

WASHINGTON (MarketWatch) -- The U.S. economy has lost some momentum in the past month or two, but the recovery is still on track, according to the best forecaster on the street in June.

The economic data have softened, said Jim O'Sullivan, chief economist for MF Global, but the temporary soft spot has not derailed the economy. "We believe a self-sustaining, jobs-creating recovery is now under way."

O'Sullivan and his top assistant, Stephanie Cheng, have pared back their forecasts for U.S. growth in response to the turmoil in Europe and the selloff in U.S. stock markets.

Jim O'Sullivan
chief economistmf global

forecast

actual*

ism

59.0%

59.7%

nonfarm payrolls

515,000

431,000

trade gap

-$40.0 bln

-$40.3 bln

retail sales

-0.3%

-1.2%

housing starts

620,000

593,000

industrial production

1.3%

1.2%

consumer price index

-0.3%

-0.2%

durable-goods orders

-1.5%

-1.1%

new home sales

325,000

300,000

consumer confidence

59.5

52.9

* Subject to revision

However, "our big-picture view remained intact," he said. They see U.S. growth decelerating to a 3% pace in the third quarter from 4% in the second before regaining speed in the fourth quarter. The economy should grow at a 3.7% pace in 2011, he says, much better than the 3% growth that the rest of the profession is predicting.

O'Sullivan won his record eighth Forecaster of the Month award from MarketWatch in June, beating out 42 other forecasters by being more accurate on 10 major U.S. indicators. O'Sullivan has won the contest twice since he set out on his own in November after he shared six titles as part of the championship team at UBS Securities that's led by Maury Harris.

Despite his upbeat view of the long-term outlook, O'Sullivan won the June contest by predicting the sharp slowdown in May retail sales, May home sales and June consumer confidence.

Much of the weakness in the indicators was payback for stronger data earlier, he said. Home sales had been stimulated by the tax credit. Retail sales had benefited from stellar sales at building materials stores. The consumer confidence index had gotten ahead of itself in April and May.

"There have been headwinds," O'Sullivan said, but they've been outweighed by the tailwinds that are pushing the economy forward. Although continued deleveraging by the private sector and the budget squeeze in state and local governments have been a drag on growth, the positives - accommodative monetary policy, massive fiscal stimulus, the inventory swing and strong global growth - have prevailed.

The economy has grown at a 3.5% annual pace since it bottomed a year ago. "That's not booming, but it's already better than the last two cycles" following the 1991 and 2001 recessions, he said.

"We are starting to get job growth," he said. Payrolls have steadily improved each quarter, going from a loss of 750,000 per month in the first quarter of 2009 to smaller losses and then gains. In the second quarter, payrolls (excluding census workers) grew by 123,000 per month, nearly double the 63,000 gain in the first quarter.

Working hours also grew rapidly, which means paychecks also grew. Total wage income increased at a 4.6% annual pace in the quarter that ended in June. Once wages pick up, the recovery becomes self-sustaining as rising incomes support more spending, which in turn creates more jobs.

If there's one thing O'Sullivan worries about, it's the stock market. "Certainly, if the equity market keeps falling, the economy is likely to weaken significantly."

The stock market is a good leading indicator of the economy for two reasons, he says.

First, long-term performance in the stock market and the economy are determined by the same factors: such as the stance of monetary policy, the levels of capital spending and the growth of consumer spending. Second, short-term moves in the markets can determine what happens in the economy, with swings directly affecting spending, confidence and investment.

O'Sullivan is bullish on the market. "It's actually a pretty positive environment for the stock market," he said.

The runners-up in the June contest were Michelle Girard of RBS Securities, Ian Shepherdson of High Frequency Economics, Stu Hoffman of PNC Financial, and David Wyss and Beth Ann Bovino of Standard & Poor's.

The median forecasts that MarketWatch publishes each week in the Economic Calendar come from the forecasts of the 10 economists who've scored the highest in our contest over the past 12 months, as well as the forecast of the most recent winner. See our complete economic calendar and consensus forecast.

Over the past year, the top economists are, in order: Girard's team at RBS (which was formerly headed by Stephen Stanley); Maury Harris's team at UBS; Nigel Gault and Brian Bethune of IHS Global Insight; Spencer Staples of EconAlpha; Peter D'Antonio of Citigroup; Wyss and Bovino of Standard & Poor's; Ethan Harris's team at Bank of America Merrill Lynch; Shepherdson of High Frequency; Lou Crandall at Wrightson ICAP; and tied for 10th, Aaron Smith and Ryan Sweet of Moody's Economy.com and David Resler's team at Nomura Securities.

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